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Mega Cap ETFs for Mega Returns

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Despite recent headwinds emanating from budget battles and the debt ceiling debate, the stock market is still near its all-time high. In addition to the drama in Washington, the uncertainty relating to Fed’s policy is likely to keep the market range-bound in the coming days.

The Fed surprised the market by announcing ‘no-taper ‘after it’s recent FOMC meeting but the fact remains that tapering has just been delayed; it is not off the table. (Read: 4 Unbeatable ETF Strategies for Q4)

This year, the rally has mostly been led by small-cap stocks, particularly in the past few months. As the US economy appeared to have better outlook than many international markets, investors poured a lot of money into smaller, domestically focused companies. Easy money further encouraged investors to invest in higher-risk, higher-growth stocks.

After the recent run-up, smaller-cap stocks appear rather expensive compared to their larger-cap cousins. Further, the Euro-zone has finally emerged out of its long recession, Japan seems to be rebounding and the Chinese economy also shows clear signs of picking up, though growth in some other emerging markets remains subdued.

Large-cap companies will benefit from the brightening global growth environment, even though currency volatility will remain a bit of a concern for them. Also, most of these companies have huge cash piles on their balance-sheets and are likely to return more cash to shreholders via dividends and buybacks, going forward. (Read: 3 ETF Winners from No Taper Shocker)

Further, per iShares research, while smaller companies perform better during an accommodative monetary period, large- and mega-cap companies outperform in the higher real interest rate environment. The following chart shows that small-cap valuations relative to those of large-cap declined as real interest rates rose.

Another reason for investing in larger companies now is that many investors who have either continued to invest in bonds or stayed on the sidelines will begin to embrace stocks when they finally realize that the bull market in bonds is over. Being very risk averse, these investors tend to favor larger, stable, well-known companies over smaller riskier players. (Read: No Taper, No problem for these dividend ETFs)

It may be thus be the right time to invest in some of the largest and the best known companies that not only look attractive on valuation basis but are also poised to outperform as the global economy recovers and interest rates in the US trend higher.

Below we have analyzed three ETFs that invest in mega-cap companies--usually defined as having market cap above $100 billion. These are large, stable companies that generate solid cash flows and add stability to the portfolios. Most of these companies have sustainable competitive advantages and fortress-like balance sheets, which ensure long-term success.

OEF is the largest fund in the space with over $3.9 billion in assets. It tracks the S&P 100 index, and holds 100 largest US companies, with an average market cap of $157.7 billion.

Top holdings include Apple, Exxon Mobil, GE, Microsoft and J&J. In terms of sector exposure, Information Technology, Financials, Healthcare and Energy take the top four spots. The product charges an expense ratio of 0.20% and has a dividend yield of 2.1% currently.

MGC follows the CRSP US Mega Cap Index, which is comprised of largest U.S. stocks representing approximately the top 70% of market capitalization. It has an AUM of $927.3 million, which are invested in 293 holdings.

The fund is pretty diversified in various sectors, with biggest allocations to Financials, Technology, Consumer Services and Healthcare. Top holdings are pretty similar to OEF, with Apple, Exxon Mobil, Microsoft, J&J and GE in the first four spots.

The product has a very low expense ratio of 12 basis points and it pays dividends at 2.16% currently.

XLG tracks the Russell Top 50 Mega Cap Index, which is comprised of the 50 largest companies in the Russell 3000 Index, representing about 40% of its total market cap. The fund has attracted assets of $513.6 million so far.

Technology, Financials, Energy and Healthcare are the top sectors the fund has exposure to. Top holdings are Apple, Exxon Mobil, GE, Microsoft and J&J. The product charges expenses of 20 basis points per annum and has a nice dividend yield of 2.63% currently.

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